Economist David Rosenberg was on the front lines of Wall Street during the global financial crisis in 2008. He saw Merrill Lynch, the firm at which he was serving as chief economist, collapse alongside Lehman Brothers Holdings Inc. and Bear Stearns Companies Inc.
The financial crisis put the health of the U.S. financial system itself in extreme jeopardy. Riddled with debt, 10 million Americans lost their homes and nine million lost their jobs. The housing bubble popped, the equities market was eviscerated and the U.S. Federal Reserve cut interest rates to zero, only to realize it had little influence to combat the problem.
There is no comparison between then and the current economic crisis brought on by the outbreak of the coronavirus, Rosenberg said. That is because, this time, it’s worse.
“In the financial crisis, air travel didn’t come to a halt, borders weren’t being closed, we weren’t talking about quarantines and self-isolation,” said Rosenberg, now the chief economist of Rosenberg Research and Associates Inc. “In the financial crisis, people weren’t scared to leave their homes. We’re talking about palpable fear and when people get fearful, they withdraw from economic activity…. The reality is the financial crisis did not come with a mortality rate.”
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In only a few weeks, Canadian and American economists have rapidly transitioned from waving off fears of a recession to debating the extent of the damage that will be done. Scotiabank, CIBC and RBC have each now said one is likely. As consumers have watched both the S&P 500 and the S&P/TSX Composite Index swing into bear market territory, with central banks and governments scrambling to stabilize the economy, it’s only natural to think back to the last time they witnessed such disruption.
World leaders are doing the same. European Central Bank President Christine Lagarde reportedly told officials earlier this week in a phone call that Europe will soon be in a situation similar to that of the crisis if governments don’t band together to combat the downturn. Bank of England governor Mark Carney also compared the two, calling the current downturn “a different kind of shock.”
And while economists are loath to agree on how substantial the impact is set to be, they echo Carney’s comments in suggesting that this downturn is different. A pandemic presents distinct challenges and requires alternative solutions.
This downturn is 'a different kind of shock.'
Mark Carney, governor, Bank of England
From almost being responsible for the collapse of the global banking system, the financial crisis, in retrospect, was brought on by a simple problem and solved with an equally straightforward solution.
Debt was at the centre of the issue in 2008 as banks, without restraint, offered subprime mortgages to countless Americans who were in no position to take them on. The banks doubled down by packaging them into mortgage-backed securities to sell to other institutions. After the housing bubble burst and Americans could no longer pay mortgages, the banks were left holding the bag.
While the stock markets collapsed, the problem was centred around one sector. When the U.S. government bailed it out with a $700 billion program to buy distressed assets, the problem was mostly solved, Rosenberg said.
This time, the banking system is actually on solid footing. It’s the main reason Rosenberg is in the minority among economists in thinking that the coronavirus downturn has the potential to be worse. This is an external challenge that is striking out at the real economy, not the players behind the scenes.
In fear of contracting the virus, consumers are already abandoning travel and tourism, or being restricted by government bans. The International Air Transport Association expects more than a US$113 billion loss in revenue due to the outbreak. On Thursday, the Walt Disney Company announced it would be closing its U.S. theme parks. Casinos in Las Vegas and Macau, meanwhile, have all but been emptied out.
Events-based businesses have also been hit hard — the NBA, NHL, MLB and MLS have each been placed on indefinite hiatus, while musical acts such as Pearl Jam, Rage Against the Machine and Miley Cyrus have canceled scheduled concerts.
Hospitality, travel and tourism will continue to be the sectors most immediately impacted by the downturn, said Brian Kingston, vice-president of policy, international and fiscal issues at the Business Council of Canada.
“But if this expands into a scenario where people are advised to stay home, this becomes a consumer story with much bigger effects,” he said. “Households don’t spend, shops and restaurants suffer, and, more broadly, other big purchases are affected. That means homes (among others). If we get to temporary layoffs then we see income declines and that’s when it’s crucial the government step in.”
Even those businesses that don’t appear to have an obvious connection to the coronavirus are being affected as offices are closed and thousands of employees are forced forced to work remotely.
We are in uncharted territory. Everybody is pricing the U.S. economy coming to a complete halt
Brian Wesbury, economist, First Trust Portfolios
In the U.S., President Donald Trump declared a national emergency on Friday to open up billions of dollars in additional spending to combat the virus. Countries such as Italy and China, meanwhile, have seen their entire economies shut down.
“We are in uncharted territory,” said Brian Wesbury, economist at First Trust Portfolios. “Everybody is pricing in the U.S. economy coming to a complete halt.”
Part of that is due to the climate of hysteria that’s been created around the virus, Wesbury said. Much of that comes down the unknowns associated with it. Officials can make estimates, but it’s still difficult to say just how far the virus will spread. As per recent estimates, the U.S. Congress received a report from its attending physician who believes 150 million Americans could be infected. In Canada, health minister Patty Hajdu warned that 30 to 70 per cent of the population could be at risk of contracting the virus.
Although Canada is handling the outbreak better than the U.S. from a public health perspective, it’s at much greater risk of recession than the U.S. is, Rosenberg said.
Canada was not immune to the economic pressures in 2008, mostly because if the U.S. enters recession, Canada is almost certain to follow. But of the G7 countries, the length of Canada’s recession was the shortest. The health of the country’s banking system, one that did not deploy subprime mortgages, was never in doubt and continue to give out loans during the downturn.
It helped that after posting budget surpluses for 10 consecutive years between 1997 and 2007, the federal government’s finances were in good order. So too were the balance sheets of consumers — a stark contrast to the staggering debt taken on by the U.S. household. Those circumstances allowed Canadians to use debt as a shock absorber, Capital Economics senior Canada economist Stephen Brown said.
Currently, that scenario has flipped. Taking advantage of low interest rates in the wake of the last recession, Canadian household debt is less than three percentage points away from the 178 per cent all-time high it reached in 2017. Corporate debt outside the banking sector is approaching 120 per cent. Simply taking on more debt won’t be an option, this time, Brown said.
Amplifying the potential for a deep recession is the global oil price shock that has sent Western Canadian Select prices plunging below $25 per barrel. Scotiabank chief economist Jean-François Perrault identified oil prices as the main driver of his recession outlook.
“You’re dealing with, peak to trough, a 50 per cent drop and for each 10 per cent move in the price of oil, you get a 0.12 to 0.13 (percentage point) reduction in Canadian growth,” Perrault said. “This really differentiates the Canadian impact from others.”
Remembering the shadow of 2008, Canadian businesses are also growing more concerned.
Joe D’Angelo, president of Kitchener’s Mitchell Plastics, has led his company through its share of hard times, including the financial crisis. Canada may have escaped the brunt of it, but the auto industry wasn’t as lucky. As a supplier to then-beleaguered automakers Chrysler and General Motors, D’Angelo was faced with a direct hit to his receivables.
“I was hoping that this one, if it had to come, would be a more typical downturn,” he said.
But already he’s struggling to see anything recognizable in the COVID-19 crisis.
“A health scare causing a confidence shock that will prevent people from spending money?” he said. “I just can’t think of another recession that’s ever worked this way.”
What makes the current situation so difficult to manage is the speed at which it is evolving, he says. In a matter of days, D’Angelo has gone from worrying about his supply chain and whether he’ll be able to secure crucial parts from shuttered factories in China to “dealing with a full health crisis.” Indeed, having managed to airlift his inputs from China, he soon pivoted back to the homefront to take on a very different challenge: protecting his own employees and operations from the virus. He’s doubling up on cleaning, communicating hand-washing techniques, and trying to address ongoing staff concerns from his 2,800 workers in Canada, the U.S. and Mexico.
In the coming days, he says, he’ll establish contingency plans for what to do if a significant number of staff members are infected with the virus.
What’s different about now, compared to 2008, is that you don’t know when the next shoe is going to drop
Keith Henry, CEO, Windsor Mold Group
Another auto parts supplier says that “what’s different about now, compared to 2008, is that you don’t know when the next shoe is going to drop.” Keith Henry, president and CEO of the Windsor Mold Group, says “you can’t sleep, or at least I can’t, because I keep running through scenarios.”
Among them: what happens if someone in an assembly plant gets the virus, shuttering production of a model that uses a product Henry manufactures? What if one of Henry’s own plants is hit by a shutdown?
“I play through all those situations and none have a silver lining,” said Henry. “That’s the big difference from what we went through in 2008: it’s so unpredictable. It’s impossible to plan.”
While the crisis affected many sectors of the economy, he added, “this has the potential to be even more widespread than that. There are so many tentacles to this thing. I mean they’re banning international travel, when has that ever happened in a recession?”
That’s the big difference from what we went through in 2008: it’s so unpredictable. It’s impossible to plan.
Keith Henry, CEO, Windsor Mold Group
CIBC economists Avery Shenfeld and Benjamin Tal painted a grim portrait of how a recession is likely to play out in Canada. There will be annualized declines of three per cent over the next two quarters, they wrote, and about a quarter of Canadian consumer spending will be lost. As layoffs begin — and the economists expect there’ll be enough to bring the unemployment rate up to seven per cent — there is the potential for an even further drag.
Even if Saudi Arabia and Russia decide to end their feud and oil prices recover, Canada could still be in danger of entering recession due to the domino effect from the U.S. With 66 per cent of our GDP reliant on trade — and 75 per cent of that figure connected to the U.S., Canada cannot afford to see swift declines in the movement of goods being exported to its neighbours.
According to Perrault, Canada exports $350 billion in goods to the U.S. and even a 20 per cent drop would cost the country $70 billion. That’s more than triple the amount he said is currently needed in fiscal stimulus to stave off a recession.
One of the lessons learned from the financial crisis is that the actions of central banks in cutting interest rates and providing liquidity to markets are simply not enough to combat a recession.
The same is true during this downturn, UBS senior economist Brian Rose said — and potentially more so.
“The thing about this circumstance is this is not the kind of situation monetary policy can really solve,” Rose said. “It’s not going to make people go on a cruise and fly in a plane.”
A real and deep recession can occur from a short period of disruption, Rose said.
That puts more emphasis on governments to provide fiscal stimulus to not only tide citizens over after they’ve lost their jobs but to encourage consumers to start spending money again, Rose said. And governments cannot wait until April or May — by then it will be too late.
It’s that realization that may have prompted Finance Minister Bill Morneau, Bank of Canada Governor Stephen Poloz and Jeremy Rudin, head of Office of the Superintendent of Financial Institutions of Canada to take the rare step of appearing together Friday to announce part of their response.
Morneau unveiled that the government would be making $10 billion immediately available to businesses through a credit facility program. Poloz, meanwhile, cut the overnight interest rate by another 50 basis points — the second time he’s done so in little more than a week — to 0.75 per cent.
Under pressure, the finance minister also promised to roll out a significant stimulus package next week.
During the financial crisis, the U.S. issued two stimulus packages worth a combined US$939 billion to jumpstart the economy again. Through tax rebates, the George W. Bush administration effectively handed out cash — up to US$600 per individual in each household and US$300 per child.
In the current environment, Perrault admits that strategy might be problematic because it may not be enough to convince Canadians to leave their homes to visit restaurants or to buy a car. But it remains the best option due to a lack of alternatives, he said. Infrastructure spending takes too long to implement, while tax cuts have proven to be less effective.
Before Morneau spoke on Friday, Rosenberg had called for a taxpayer-supported loan facility to be set up because he was concerned with the knock-on effects of the recession leading to a credit shock.
Access to credit is going to be pulled back, he said, as well as the ability to refinance debt and so businesses needed a support program to help them skate by the recession.
So far, the government has been up to the task and is demonstrating a response proportional to the challenge, Rosenberg said. But they need to do more. Using one per cent of GDP may simply not be enough to combat this recession.
Both the financial crisis and dot-com bubble bursting in the late 1990s could have been averted if governments treated them more seriously early on and realized how destructive their potential was.
For Canada, the risks are there and so rather than repeat the mistakes of the past, Rosenberg hopes for a strong pre-emptive strike.
“I don’t care whether it’s 0.5, one or two per cent of GDP,” Rosenberg said. “To me, it’s ridiculous to be talking about going small. At this point, we have to throw out whatever cautionary fiscal approach we would’ve had otherwise.”
